What is a common size income statement?

Definition and Example

A common-size income statement is an income statement in which each item is expressed as a percentage of total sales or revenue. The common-size income statement provides a tool for analyzing a company’s historical performance over multiple periods (quarters or years).

The common-size income statement also allows for the comparison of line item entries with competitors, in addition to being a useful tool for comparing company performance over multiple years. It helps investors determine how the business performs within its specific industry.

How Does a Common-Size Income Statement Work?

A common-size income statement can help company leaders and investors identify what drives profits or what negatively affects them. Decision-makers can compare key percentages from year to year or over several years to identify trends that may indicate what could be beneficial for profits or what may be negatively impacting earnings.

Understanding the chart shown above can prompt leaders of the company to explore why the cost of goods sold increased by more than 4.5% in the last year, as this could impact profits. In this case, it might have been a supply issue that temporarily drove up material costs. Or, if the cost of goods sold is expected to remain at this higher level, the company may want to raise its product prices.

Total profits in the example remain steady over the three years, while wages decreased in 2020 compared to 2019 but increased again in 2021. This could be, for example, a result of layoffs and re-hiring.

Overall, total operating expenses in this scenario declined by more than 3 percentage points in 2020 and then increased again in 2021. If the leaders of this company could dig deeper and identify ways to keep expenses close to the total of 2020 in the coming years, it could lead to an increase in overall profits.

Advantages and Disadvantages of the Common-Size Income Statement

A common-size income statement can provide valuable information for investors and company leaders. However, it may not be sufficient on its own for a comprehensive analysis of the company’s financial situation.

Here are some advantages and disadvantages of using a common-size income statement.

Advantages:

• Highlights key figures: Converting key figures into a percentage of revenue allows investors to understand various items beyond just the numbers, helping in comparing years on an overall percentage basis.
• Aids in comparing companies of different sizes: Since items are presented as a percentage of total revenue, it is easier to compare the financial data of a $1 billion company with that of a smaller company.

Disadvantages:

• Lack of information: The common-size income statement might not provide enough critical information for a comprehensive analysis. For instance, it may lack information regarding the company’s industry, competitive considerations, leadership changes, governance, and more.
• No explanations provided: The common-size income statement does not provide explanations for significant variations in line items from year to year.
• Does not identify non-financial factors: Many factors that can influence long-term success are not detailed in income statements, so investors need to conduct further research to ascertain this information.

What Does This Mean for Individual Investors?

For investors, analyzing the common-size income statement allows them to identify significant changes or trends in the company’s income and other finances. This data can provide useful tools to gauge whether the company is moving in the right direction and to compare businesses of different sizes.

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Corporate leaders can also benefit from common size income statement data. However, the financial data may not provide all the information needed by investors or corporate leaders. Therefore, they should also look into conducting research beyond the company’s financial data.

Key Points

• The common size income statement presents each item in the statement as a percentage of total sales or revenues.
• The common size income statement is characterized by containing data for several years, which helps investors identify trends.
• Investors can use the common size income statement to easily compare companies of different sizes.
• The common size income statement may not take into account many factors and may not provide a complete financial picture of the company.

Source: https://www.thebalancemoney.com/what-is-a-common-size-income-statement-5215579